Question

What are the differences between traditional and activity-based costing systems? In what type of situation would an organization choose one over the other? Note GAAP's requirements. Does size of company, # of products, etc. matter?

Answer 1

1)Overhead in Traditional Vs ABC Costing

	Traditional	ABC
Overhead Assigned	Single cost driver	Multiple Cost drovers
Optimal Usage	When direct labour is Large potion of product cost	When Technological cost is a Large portion of product cost
Orientation	Cost driven	Process Driven

* Traditional allocation assigns overhead based on a single overhead rate, while ABC assigns overhead based on several cost pools and the activities that drive costs

* Traditional allocation is optimal when the manufacturing process is labor driven and overhead increases based on traditional activity bases, such as direct labor hours, direct labor dollars, or machine hours.

ABC costing is optimal when the manufacturing process is technology driven and overhead increases based on various activities that differ for each product.

* Traditonal costing is simpler and easier to understand.A new employee or inexperienced people will be more happy to choose traditional method.whereas, Activity based costing is More accurate . ABC systems are more complex and more costly to implement. The leap from traditional costing to activity based costing is difficult.

2) Both methids estimate overhead costs related yo production and then assign those costs to products based on a cost driven rate.The difference is in accuracy and complexity.

Traditional costing is the allocation of factory overhead to products based on the volume of production resources consumed. Under this method, overhead is usually applied based on either the amount of direct labor hours consumed or machine hours used.If a company needs such an costing method,which is easy and non complicated.

Activity-based costing (ABC) is mostly used in the manufacturing industry since it enhances the reliability of cost data, hence producing nearly true costs and better classifying the costs incurred by the company during its production process.